Learn The Stock Market Lesson – The Mind of the Stock Market : Why Do Stock Prices Go Up?
The Fact:
Like many traders, I myself, once believed that prices go up when there are more buyers than sellers and down when there are more sellers than buyers. However, Dr. Alexander Elder stated in his book, “Trading For A Living,” that, although, the previous statement seems logical, it is not true. This is because the number of instruments, such as stocks or futures, bought and sold in any market is always equal by definition. If you want to buy a share of a stock, someone has to sell it to you. Likewise, if you want to sell short a certain share, someone has to buy it from you. It takes two to transact. Essentially, the number of stocks bought and sold is equal in the stock market just as the number of long and short positions in the futures market is always equal. If there is an odd amount, such as only one buyer or only one seller, there is no trade and therefore, there will be no price movement. Rather, the common logic and argument that people hold refer only to those willing to buy and sell.
So Why Does Price Rise And Fall Then?
Prices rise and fall due to the alterations in the intensity of greed and fear among buyers and sellers. This means that every change in price reflects the battle between the bulls and bears. Price rises when buyers feel confident and do not mind paying a little extra because they are expecting prices to rise even higher. When these optimistic bulls meet the fearful and defensive bears, the market rallies and continues as long as bull are greedy enough to meet sellers’ demands.
The more aggressive their feelings are, the sharper the rally is. For example, if buyers feel just a little stronger than sellers, the market rises slowly. It is the job of technical analysts to determine exactly when the buyers are strong and when they are not.
Similarly, the rally ends when many bulls lose their enthusiasm, causing the price to slide. There is now greed among bears and fear among bulls. That’s when the bears feel optimistic and do not care about selling short at lower prices. Bulls are now the fearful ones and they agree to buy only at a discount. As long as bears feel like winners, they continue to sell at lower prices. The downtrend continues until the bears start feeling cautious and refuse to sell at lower prices.
As you can see, the process is more complex than the view that stocks go up when there are more buyers than sellers and down when there are more sellers than buyers. Rather, it relates more to market “panics” in buying or selling. To conclude, there are never more buyers than sellers or more seller than buyers.
For more information, I recommend you to read Dr. Elder’s “Trading For A Living.” This was the first book that I read when I began my trading career and until this day, it is still one of my favorite books. The book covers a lot about trading psychology, which I mentioned in an earlier post that it is crucial to control your emotions. So if you guys haven’t already, I suggest you go to the nearest library and pick up his book or just go on Amazon and purchase it from there.
Tags: dr. alexander elder, fear, futures, greed, stock market, stock market lesson, stocks, the mind of the market, the stock market, trading for a living, trading psychology, why does price go up
To me the market is more akin to a flea market. In a flea market, there are a wide variety of items for sale at various prices. If you were looking for a toy you may find that toy for sale at a price that you want to pay. If, for some reason there is a flurry of interest in say Cabbage Patch Dolls, you might find that there is more interest in them and people are willing to pay more than they normally would. As people note the interest in the dolls, willing sellers might take advantage of the interest to make a profit. Some noticing the heightened interest will hold out for higher prices. That leaves the buyers to decide if there is a substitute similar toy, such as a Talking Elmo that can take it’s place. You may find ’sympathetic’ price increases in similar toys/stocks. Eventually, what happens is the price for Cabbage Patch Dolls becomes excessive, or its seasonality peaks (post Xmas). Sellers that held out for higher prices now have to drop their price. Late buyers will find that the price they paid is higher than the going prices for the same product new. If they don’t have too much skin in the game, they might sell at a loss. And we have the down trend. Eventually, Cabbage Patch Dolls are on the ‘Any item $1.00′ table. You only have to have witnessed the Beanie Baby mania to understand the stock market.
Thx for the article.. UrbaneGorilla ;=)
UrbaneGorilla,
Thank you for your wonderful comment. =D
I like how you compared the stock market to a flea market. I actually never thought of that before until you mentioned it now. Yes, there are many similarities between them, just like how you described in your comment — our interest in toys, how much buyers will be willing to pay, and how much sellers are willing to sell them to us. Nice thinking! =)
-Dojitrading